Hickey: IRS Offers Advice on PPP Loan Spending
Taxpayers have received additional guidance from the IRS regarding the deductibility of expenses paid with Paycheck Protection Program loans, but not in a direction that many would have appreciated.
Background. First, according to the CARES (Coronavirus Aid, Relief, and Economic Security) law, a taxpayer who has received a PPP loan is generally eligible for loan cancellation if they have used the proceeds for certain eligible expenses listed in the law. CARES. Second, in guidelines released in May (IRS Notice 2020-32), the IRS took the position that a taxpayer receiving a PPP loan cannot deduct qualifying expenses that he pays with the loan proceeds. PPP (PPP expenditure). The rationale for this position comes from Section 265 of the Internal Revenue Code (IRC), which denies deductions for expenses related to tax-exempt income. The IRS considers a canceled PPP loan to be tax-exempt income for the taxpayer and the PPP expenses to be directly related to that income. These guidelines did not address the issue of when to surrender a PPP loan one year later than the year in which the PPP expenditures were incurred.
New direction – Timing of non-deductibility of PPP expenses. In mid-November, the IRS issued Tax Decision 2020-27, which provides additional guidance on the timing of the non-deductibility of PPP expenses. In short, if the taxpayer has a “reasonable expectation” of a PPP loan forgiveness, the PPP expenses are not deductible in 2020. This is the case even if the taxpayer has not received a PPP loan forgiveness before the end of 2020. As per IRS guidelines, a “reasonable expectation” includes: (i) incurring qualifying expenses, meeting other CARES law requirements for remission, and requesting remission from the taxpayer’s lender. ; and (ii) incur qualifying expenses and meet other CARES law requirements for remission, but not expecting to request a remission until 2021. The IRS has extended its rationale discussed above, asserting that the IRC section 265 applies to deny a deduction for expenses related to tax-exempt income regardless of when that tax-exempt income is received by the taxpayer.
At the same time, the IRS also issued Revenue Procedure 2020-51, which provides a safe harbor in the event that the taxpayer’s “reasonable expectation” of PPP loan cancellation turns out to be incorrect. This could happen if the PPP loan is ultimately not canceled or if the taxpayer takes irrevocable action preventing the cancellation, such as withdrawing a cancellation request. In either case, if the event occurs before the taxpayer’s 2020 return is filed, the taxpayer can deduct the PPP expenses on their 2020 return. If the event occurs after the taxpayer’s 2020 tax return is filed , the taxpayer can either (i) file an amended return for the 2020 tax year in order to deduct the initially denied PPP expenses, or (ii) deduct these expenses in the 2021 tax year. The guidelines provide additional procedures if the taxpayer wishes to claim the benefits of the Safe Harbor, including attaching a declaration and relevant information to the relevant tax return.
Taxpayers may wish to consult their tax advisors to determine whether these new IRS guidelines will affect their tax obligations for 2020.
Matthew B. Hickey is a lawyer at Crowe & Dunlevy, crowedunlevy.com, and chairman of the firm’s tax practice group.